MILAN, Sept 23 (Reuters) - Spanish telecoms company
Telefonica has agreed to hike its stake in rival
Telecom Italia, a source close to the deal said,
ending months of speculation on the future of the debt-laden
Italian group and opening the way to asset sales.

Under the terms of the deal, to be announced on Tuesday,
Telefonica will boost its stake in Telco, the holding company
that controls Telecom Italia, to an initial 65 percent with an
option to bring the stake to around 70 percent, a source with
direct knowledge of the situation told Reuters on Monday.

Telefonica is already Telco's biggest shareholder with a
stake of 46 percent, or about 10 percent of Telecom Italia
shares. It will boost its stake in the Italian group to nearly
16 percent.

Telefonica is set to acquire its additional shares from the
other Telco shareholders: Italian banks Mediobanca and
Intesa Sanpaolo and insurer Generali.

The deal involves a "debt and equity" component, the source
said, without elaborating.

The deal is likely to lead to the sale or partial sale of
Telecom Italia's treasured Brazilian unit Tim Participacoes,
worth $10 billion on the market, as the increased Telefonica
stake will likely generate antitrust problems.

Telefonica and Telecom Italia were not immediately available
to comment. The Italian shareholders declined to comment.

Telefonica and the other Telco shareholders took control of
Telecom Italia in 2007 in a deal that valued the Italian
company's shares a hefty 2.8 euros a share.

Telecom Italia, hit by a deep recession at home, had since
struggled to deliver investment returns and the Italian
shareholders were eager to offload their holdings, several
sources have told Reuters.

Telco owns 22.4 percent of Telecom Italia and its investors,
bound in a pact, were faced with a Sept. 28 deadline on whether
to quit their pact early and sell their shares.

In Rome, a deputy minister signalled on Monday the
government would not block a foreign takeover of Telecom Italia.

"We all would like that companies remain Italian, but this
would be a dream, the real world is that made of global
competition," said Italy's deputy Industry minister Antonio
Catricala on Monday.

Telefonica has been studying various options to buy out the
other Telco investors without adding to its own substantial debt
burden.

Telecom Italia, which risks having its credit rating being
cut to junk in the coming weeks, has struggled to grow because
of its 29 billion euro debt and falling margins.
(Additional reporting by Gianluca Semeraro and Lisa Jucca in
Milan, Writing by Lisa Jucca; Editing by Ken Wills)